Where is the Housing Market Headed?

As a long-term Real Estate investor, I am always trying to determine where the money is to be made in Real Estate. I personally like passive income generated through being a landlord. It’s not as passive as some would like, but it is passive in terms of the IRS.

I write about the non-passive nature of self-managed rental property and some of the adventures on my personal blog.

If you are a short term investor, a ‘flipper’, you are somewhat insulated by the long term direction of Real Estate. If you only hold for three or four months, your window of risk is short.

If you are a long term investor, which many homeowners are, the direction of RE could make or break you. Many people are relying on their home to enhance their retirement life style.

If you are a landlord, you are expecting rents to go up, property appreciation to happen, and an eventual mortgage payoff. The fruits of your labor at some point will allow you to enjoy sipping margaritas on the beach. RE has been the ticket to wealth in the past; will it continue to do so?

There are a lot of unknowns in the game of RE investment. Tax rates, property values, inflation, projected rent increases, vacancy rates and a lot of other factors feed into your financial picture when you own real estate. If you had a crystal ball, all would be easy. Here are some thoughts that I think about what the future in RE will bring.

What Drives Housing Prices?

People segregate themselves in various neighborhoods based on the economic status of the neighborhood.

That is what the term “location, Location, location” is all about. All the homes in the neighborhood are roughly the same price, if you have the largest most expensive home on a block, you probably paid too much. The reverse is true of a smaller home. That is RE 101. Never own the most expensive piece of property on the block. That said, most of the people living on that block make similar incomes, hence they can afford it.

They would likely not be able to move into a more expensive neighborhood, nor would they want to move to a less expensive area. If they did, they would already be there. Doctors and Lawyers do not move into low income areas, and low income people do not live in beach houses.

When people choose where to live, it is in a neighborhood with similar people with similar economic backgrounds and ability to pay. If that neighborhood gets priced too high, there is no one available to replace them. There is an limit to how high prices can go.

It’s Not the Price, It’s The Price Per Month

Housing is a function of a monthly payment.

That is, no one except a cash buyer buys a property on the total value; they buy a monthly mortgage payment. That payment includes principal, interest, taxes, insurance, MIP and even HOA dues. All of these affect the amount someone can qualify for.

If any one of the expenses goes up, the amount to put towards principal must go down in order to keep the same payment. When the amount allotted for principal goes down, the total value of a mortgage drops, and the value of the home drops. It’s that simple. Prices of any goods or services cannot go up beyond people’s ability or desire to pay for it.

As long as wages rise faster than the inputs to a mortgage, and the other expenses a typical household has, there is generally not an issue. People make more, they can spend more. The market will slowly trend up with the availability of money chasing the goods.

Increasing expenses will put pressure on RE prices to move down.

Interest Rates

What we have right now, is historically low interest rates.

With a lower rate, people could own two homes very easily. The increased demand increased prices. Odds are, interest rates will not fall further, and there is not much room to fall even if they did. There are no competing investment alternatives, but if rates rise, there will be. If rates rise, there is less to put towards principal on a monthly payment.

Wages

In all but the elite in society, wages are not rising.

If you look at the trend in real wages, it is headed down. Some would argue that workers have increased benefits, so the total package is worth more, but an employer paying more for healthcare does nothing to add to a workers ability to pay more for a mortgage.

There are many available jobs, but they are not paying a solid enough scale to purchase RE. Manufacturing jobs are almost non-existent, compared to even twenty years ago.

Lower wages will put pressure on RE prices to move down.

Taxes and Higher Prices

Taxes to fund schools and infrastructure are rising.

Whether it is a gas tax, a school levy, property taxes, or even the cost of a Big Mac going up, all these things take away from a purchaser’s ability to pay a monthly payment. Factors that are directly related to a mortgage are the big detractors, but all of them eventually factor in. If the price of gas went to $10 per gallon overnight, you would see the amount of foreclosures increase.

Increasing taxes and prices will put pressure on RE prices to move down.

Inventory Availability

Much has been written about property availability.

In 2008 through 2012, inventory was plentiful. Short sales and other distressed properties made up the bulk of the sales. Once those dried up, few owners who wanted to sell could walk away from a closing table without writing a check. As prices begin to increase, more supply will come on the market. People become solvent in their mortgage, and more supply comes on the market. This will produce a damper on prices.

Increasing inventory will put pressure on RE prices to move down.

Population Demographics

When there is increased demand for any product, the price generally increases.

When the population increases, but it cannot afford the product, it may not. Virtually every demographic study of the future trends of the population shows changing demographics. Unless the future demographic model is significantly changed in terms of economic distribution from the current one, future populations are more likely to be lower skilled and lower paid.

Unless we raise the minimum wage, and recognize that being a fast food worker can be a lifetime career, housing prices for the masses will remain too high.

Demographic trends will put pressure on RE prices to move down.

Mobile Generation

Owning a home is not the American Dream anymore.

As employers have given up on creating jobs for employees that last them their entire life, younger people have given up on the housing market. They would rather rent, and not get tied down to a mortgage. If things get bad, they can move to another area of the city or even country. Home ownership is falling, and will continue to do so.

Less desire for home ownership will put pressure on RE prices to move down.

Apartments and Multifamily Housing Will Rule

With the majority of the upcoming populations being renters, multifamily will be the place to be. Renting a single family home will be second best. There is less profit and cash flow in a single family if you do not get price appreciation.

More and more apartments will be built, and Government will begin to provide more and more housing to the less fortunate. Some of that will be in the form of vouchers for the private market, some will be Government housing. More regulations swill be put in place to ensure safe housing, so if you are a landlord, make sure you maintain your property.

A renter society will put pressure on rent prices to move up.

What Will Save Housing?

Higher Wages. Higher wages and employment stability are the number one things that will propel the housing market forward. Whether that is in the form of increased minimum wages, more manufacturing in the US, or more government jobs, employment stability will be crucial. With a higher minimum wage, more people can afford homes.

Smaller Payments. If mortgages go to a 50 year model, monthly prices will be lower. Lower prices mean more demand. Perhaps a gradual mortgage forgiveness program if you hold your own home over 10 years.

Easier Qualifications. If it was easier to qualify for a mortgage, more people would be able to be a purchaser and increase demand. In the ‘old days’, banks made money on a foreclosure due to the quickly rising property values. In today’s market, they have to make money on the mortgage. Banks only loan to people that can pay the mortgage back. Perhaps waiving the MIP requirements for lower income borrowers would make homes more affordable and increase demand.

Less Expensive Construction. There is a move to build ‘Tiny Houses’. While that is the extreme, if the square footage decreases, so will the price.

More People Living In the same Place. As families take on extra roommates or additional generations of the family, there is more income to support a housing payment. When you have four earners, instead of two, you should have more for a housing payment.

Will housing prices go up, or down? No one knows for sure, but in 10 years we can look back and said “We should have seen it coming”. What do you think?

Be sure to leave your comments below!

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About Author

Eric is a 55 year old, soon to be former, computer professional. He started several years ago to replace his “work income”, with other alternate streams. He is well on his way to retirement at age 56, and is currently making more money at extracurricular activities, than he is working at his full time job. Whether that is Financially Independent, or just old fashioned entrepreneurial spirit, is in the eyes of the beholder.

Smaller homes such has mobile homes, RVs, and other efficient, relatively inexpensieve, and transportable forms.

While the above blog is a projection based on the current situation, I believe there will be other factors that will come into play that will transform housing as we currently know it. Society will find a way.

You are correct. Smaller homes, on smaller lots, will definitely be an option. More apartment style living arrangements where many people can live in a smaller, cheaper footprint.

in a capitalist society, someone will find a way to make money and provide solutions. It could even be that the Government steps in and becomes the ‘provider of choice’ for the majority of the population. If it is perceived that ‘landlords’ are making too much money, regulations and taxes will be put in place to siphon it back to the populace.

Another nice article. As someone who writes with a sarcastic meandering style….I find your bare bones and to the point style refreshing. I agree with you that we are moving towards a renting society, (especially with the Millennial generation). I have been looking at Duplex Homes as compared to apartment buildings because Commercial property requires a 35% down payment. When you mention Multifamily homes are you speaking of apartment buildings? For someone like myself that may not have 100-150k for a down payment are Duplex’s a good place to start?

All my multifamily buildings are duplexes and 4-plexes. With a live-in building, even a 4-plex, you can get a lower down. Most non-owner occupied require 25-30% down, and cash reserves. Other ways to get in with a smaller investment are partnerships and syndicates.

If you just do not have any money, some options are seller financing, using your home equity, a part time job, picking up a side hustle to get extra money. I actually wrote on my own blog about a side hustle I did and made decent money that helped propel my investing cash. Lokk for wholesale deals. I was purchasing 4-plexes in a class A neighborhood for $270K.

Prices are a function of market forces. For every market force there is an opposite force. This article is focusing only on the negative side of these forces, but I think there are even stronger positive forces for each one of these arguments.

1. Monthly Payment – It is true that people buy houses on monthly payments not on total value. But they rarely focus just on what they think is a reasonable monthly payment. As mentioned in the article it is what the user can qualify for. In the last 5 years banks have tightened lending standards drastically and are only starting to loosen them. In fact there is an article just today in the Minneapolis Star Tribune business section that discusses banks lowering lending standards in the 2nd quarter for prime borrowers. Sub prime standards are still very tight but eventually those will loosen as well. Over the coming years they will continue to loosen standards even more. The looser the standards get the lower the down payment requirements will get and the higher percentage of debt they will let the borrower carry. This may not be a wise path but it is the pattern and the one that will be followed. This will give borrowers more purchasing power and will tend to drive prices higher as more people will be able to get started with lower downpayments and the banks will allow higher over all payments.

2. Interest Rates – It is true that we have very low interest rates, however interest rates were much higher when the prices were much higher and as prices were falling through the floor interest rates were doing the same. It is true that higher interest rates will mean higher payments but higher interest rates generally come with a stronger economy and more buyer confidence. Kenny Estes wrote a blog post here last December that showed how interest rates don’t actually have much historical correlation with real estate values. Interest rate rises are likely to be modest whenever they start and their impact on housing values will probably be minimal as they will be offset by the other positives that come with the environment that lead to higher interest rates.

3. Wages – Wages have been stagnate for a number of years and housing prices definitely cannot get too far removed from wages. However the job economy is slowly getting better even if at a much slower pace than hoped for. The most recent wage data shows 2.9% annual wage increases this year with 3.0% expected for the coming year. Those numbers will support modest real estate appreciation.

4. Taxes and higher prices – People always complain about taxes and prices going up. They usually do go up and will likely continue doing so. This is nothing new. In fact prices can only keep going up if wages keep up. Otherwise no one could pay the increased prices. So either increased prices will be followed by wage increases or they will stop. As of yet there does not appear to be any drastic increase in prices. In fact inflation has been trending down for 30 years and is at very low levels. Price increases do not appear to be a large concern for the near future. If inflation does start it is likely to take asset values with it. Broad based inflation like that in the 70’s hits everything, including real estate, as it did then.

5. Inventory – Inventory is moving back up but from extremely low levels and are still at levels far below what they previously were. Increasing inventory will put a damper on current price increases but that doesn’t mean they will drive prices down. If prices begin to drop the inventory will dry up. People do not like to sell at a loss and many simply cannot afford to. The only thing that drove down house prices was bank forclosures. Unless we repeat that story prices will not fall much. That had not happened in over 50 years. It is unlikely to happen again so soon especially from these much lower price points. Increasing inventory is more likely to be a sign of increased demand that is driving prices higher and inducing sellers to bring on more supply. When that reaches equilibrium price increases will slow to much more normal levels but it does not mean they will decline for more than very short periods of time.

6. Population and Demographics – population increases drive more demand for houses. There are more people going to college now than ever so I am not sure why the future population would be lower skilled. The past 6 years has seen a large pent up demand for houses sitting on the sideline. They either have been too scared of the housing market to buy, prevented due to bank lending standards, or unable to due to job loss. The housing market feels safer to these buyers every day as prices continue to rise and the foreclosures are mostly worked through, the banks are loosening their standards and the unemployment rate is back down to levels that pre-date the crisis. We can argue about whether or not the reported unemployment numbers are fully reflective of the situation but the trend is clear and that is less unemployment and more jobs. All of these are positive for housing.

7. Mobile Generation – It is true that the younger generation tends to be more mobile and they may be delaying starting a family and “settling down” until later but that is also pent up demand. The funny thing about young people is they get older. 40 year olds tend to grow tired of the mobile lifestyle. Eventually many of these people will desire to own their own home. Homeownership has been declining for the last 6 years to levels that date back multiple decades. That was mostly driven by the housing crash. While there may be a demographic component, many of those people who lost a house want to own one again. We are coming up on the time period where many of these people will qualify for a loan once again. This is also more pent up demand and it will enter back into the housing market over the coming decade. The home ownership rate has likely reached a short term bottom and will not go much lower from here. Over the coming decade it will probably increase a little bit as we work through the effects of the housing crash.

8. Apartments will rule – There is no doubt that an apartment boom has been going on. Rents are high and this drives apartment owners to build. But this is also due to a shortage of housing as units built over the last 6 years were at multi-decade lows which means while inventory of housing available may have been too high prior to the crash it is likely too low now. That is positive for both apartments and houses. Until supply and demand are equalized there will be pressure on prices to move up for both.

9. What will save housing? – I would say housing looks to be doing just fine and will continue doing fine for years to come. Make no mistake, black swan events do happen, but we just had one. The fear may still be palpable but black swans are proceeded by greed, not fear. If a typical house in a typical area of the country today was sold in the future after 1 year, 5 years, 10 years and 20 years and I had to bet on what the prices trends of each sale would be, I would bet higher in each case, without hesitation.

Only time will tell. Meanwhile, mortgage applications are at an all time low, even with the low rates. Home ownership is falling, and more and more people do not even want to buy. This is not the 1950’s anymore.

If housing prices start to rise, Banks will take on more risk and make loans. They can recoup their losses with the appreciated value. If rates rise, more banks will loan as spreads get bigger.

I feel we have a structural issue with the economy. Only time will tell. Regardless what happens, “No one knows for sure, but in 10 years we can look back and said “We should have seen it coming”

I agree wholeheartedly with Darin. I’m in the market every day and see what’s going on (at least in the Chicago area market) Inventory is still historically low. Most agents I speak with on a daily basis can barely get their listings on the MLS before multiple offers are made. Market times have compressed, selling prices have escalated – but not at a rate that causes alarm, and the commercial real estate is just now starting to take off again. The commercial market will only bolster the residential market which has been exploding for almost a year. This sounds like nothing more than uninformed pessimism.

Hopefully prices will continue to rise, and profitability continues to increase. In the meantime, wages are headed down except for a few elite segments of workers. Who knows, maybe the minimum wage will rise up and all prices will head up.

There continual worries about Europe in deflation. Japan headed into another recession, cash sales on homes declining, etc.

If the rental market stays strong, that will be the salvation. If cap rates fall to sub-5% for a class C property, rather than an expected 10%, that would increases housing prices immensely and still provide affordable rents.

Great article, Eric! I like what you said about the monthly payments. I know it’s “location, location, location”, but I have also heard “financing, financing, financing”. Getting into the right house, at the right price, with the wrong financing can eat all of your investment and savings in that house.

Great article. I agree with most of your commentary. Even in the SFH arena there is a significant possibility of arbitrage by financing one’s rentals at a long term low interest rate and seeing interest rates rise. Rents will rise based on present day interest rates and you will be locked in at a lower rate.

We’ve been waiting for a few years for interest rates to move up. At this point though the fed will scale down QE to 0 before raising rates. Could be another 5-7 years of low interest rates…

I too believe interest rates are going to be about where they are for a while. I think we might be on the Japan model with low rates, but I am not sure how much lower they will go. Our national deficit will sky rocket if it does.

Nice article Eric! One thing you may want to consider is the role of institutional investors, hedge funds, and private equity in the future of residential and smaller multifamily properties.

For instance Blackstone has purchased over 40,000 homes that it has successfully issued rent backed mortgage securities on. This effectively sets the stage for what could be a dynamic shift in home ownership away from individuals towards corporations.

In an ironic twist the statement: “Less desire for home ownership will put pressure on RE prices to move down.” in fact may be the cause of a greater demand for rentals which further drives institutional investor participation. These investors have vast access to leverage which allows them to comfortably accept 3-5% returns on residential rentals. Contrast this with mom and pop landlords who need nearly double that return range to make sense out of owning a rental property.

I see a possible future of razor thin rental returns on real estate and easy access to leverage for corporate landlords. The obvious result of which is a shift from a society of home owners to one of renters.

Corporate investors will still remain, it depends on how low of a return they are willing to accept. i think they need quite a bit more, unless they are going after class A tenants. But they could get government subsidies, and then all bets are off.

I think large investors have slowed down their buying with less foreclosures and the Stock Market being so strong.